Deze samenvatting is gebaseerd op het studiejaar 2013-2014.
§A.1 ‘The global economy- Some general information’
There is no one standard answer to the question: “What is globalization?”. Globalization means different things to different people. Take farm leaders, trade unionists and human rights activists as an example ; they all see different pros and cons for globalization.
Based on this argumentation, there are five key issues to be considered:
Cultural globalization > Which is about the debate whether there is one big global culture or a set of universal cultural variables, and the degree to which these universal cultural variables displace embedded national cultures and traditions.
An example that illustrates this debate: there are people afraid of ‘McDonaldization’ (hige multinationals are the carriers of culture globalization) and there are people seeing enough room for local traditions.
Economic globalization > Which is about the decline of national markets and the rise of global markets. Drivers for economic globalization are fundamental changes in technology which permit more efficient ways of internationally organizing production processes.
Geographical globalization > Which is about the result of ‘joint time and space’ due to reduced travel times and the rapid (electronic) exchange of information. Some neo-liberals named this development the ‘end of geography’ in which location no longer matters.
Institutional globalization > Which is about the spread of universal institutional regulations across the world, triggered by US President Reagan’s and UK Prime Minister Thatcher’s ‘revolution’ of neo-liberalism. These neo-liberal policies are represented by institutions such as the IMF (International Monetary Fund), the WB (World Bank) and the WTO (World Trade Organization). These universal institutional regulations are not only on macro-economic level, but also on the micro-economic level: multinationals adopt similar policies under the pressure of competition and regulation.
Political globalization > Which is about the relationship between the power of the market (multinational corporations) versus the nation-state, which continuously has to make changes and updates in reaction to economic and political forces. Popular anti-globalists stress that large multinationals become more and more powerful, out-powering the majority of nation-states. In contradiction, others point out that real evidence for these fears is lacking, as the state has to provide security, a legal system, education and infrastructure, which are all of vital importance for economic activity and growth.
Keynes once said that the master economist should “examine the present in light of the past, for the purpose of the future”, by which the common opinion about economic globalization was that it was a totally new phenomenon with overwhelming power. Later research, however, showed that it is historically seen not a new phenomenon at all.
§A.2 ‘Globalization and welfare’
Before explaining the topic of this section, let’s first take a look at logarithmic graphs:
Note: This explanation of logarithmic graphs is based on Figure 1.7 in the book
A logarithmic scale is a scale that divides the vertical axis in steps of ten-fold increases: 1-10-100-1000-10000.
The important advantage of a logarithmic graph is that it can simultaneously show the developments in the level of a variable and its growth rate, where the slope (rise/run) of the line reflects the variable’s growth rate. In Figure 1.7, Variable A grows constantly by 14,7% per year. Variable B has no constant growth rate (-5% for the first 30 years and then 8%). C, finally, does not grow at all: 0%, so a straight line.
The important disadvantage of logarithmic graphs is that they can be misleading concerning the difference in levels for variables at the same point in time and for the same variable at different points in time. Let’s illustrate this;
In 1950, the difference between variables A and B is about twice that between the variables B and C, because the vertical difference is twice as large. However, this is a logarithmic graph, so these differences are multiplicative: the level of variable C is 100 times higher than the level of A
In 2000, if the variables all measure something positive, variable A obviously has fared better than variables B and C. But how much better? This is hard to tell from the figure
Now, back to the theory: globalization and welfare.
To describe the evolution of income over time, researcher Angus Maddison uses so-called ‘1990 international dollars’. Maddison collects data for virtually all countries in the world . The development of the world per capita income is illustrated in Figure 1.6, using a logarithmic scale. The logarithmic scale shows the level of income and the growth rate of the income. As you can see in the figure ; world income per capita only started to increase from the year 1000-1800 approximately. Since 1800, per capita world income rose more than eleven-fold in a period of 188 years. Maddison made a note: not only per capita incomes are a measure of welfare, life expectation also is.
* ‘Leading and Lagging nations in terms of relative GDP/capita index’
The calculations of the deviation index of GDP per capita can be split in above the world average and below the world average. The calculations over 2000 years are available for 28 individual countries and 6 country groups, together covering the global economy. See Figure 1.8 + description: at the beginning of our calendar (year 0): the leading country was Italy, where many other countries were laggards. Later on, the Netherlands, the USA, Switzerland, Australia and the UK became leaders, where Africa, China, India and Iraq became laggards.
§A.3 ‘Globalization’s manifestation on international trade and business’
The most significant manifestation of the idea of a global economy is the rise in international trade and capital flows. Capital flows are not a completely new phenomenon, in the ancient cultures of Egypt and Greece for example such flows have always been central in economic interactions. According to Maddison, capital flows have been the most important for the economic rise of Western Europe the past millennium (Recap: Figure 1.8)
* Historical overview of the developments in the world economy
Venice: key figure in the economic rise of Western Europe (1000-1500):
Based on improved techniques of shipbuilding and navigation (the compass), Venice opened up trade routes within Europe, the Mediterranean and to China via the caravan routes, bringing in products and new technology (relevant for that time)
By establishing a system of public finance, Venice became the lead economy of the period
Portugal: more ambitious interactions between Europe and the rest of the world (second half of the 15th century)
By opening up trade and settlement in the Atlantic islands
By developing trade routes around Africa, to China, Japan and India
Portugal’s geographic location enabled its fishermen to gather knowledge of Atlantic winds, weather and tides
Portugal soon became the dominant player in the intercontinental trade due to the gained knowledge, maritime experience and the inventions Venice already did (improved techniques of shipbuilding and navigation)
The Netherlands: most dynamic economy (1400-mid 17th century)
By creating large canal networks
By developing shipping, shipbuilding and commercial services > Figure 1.9 shows how the carrying capacity of Dutch merchant shipping was about the same as the combined fleets of Britain, France and Germany.
By providing property rights, education and religious tolerance
Only 40% of the labour force in agriculture > a financial and entrepreneurial elite from Flanders and Brabant emigrated to Holland on a large scale > Holland became the centre for banking, finance and international commerce
Britain: leading economy (18th century)
By improving its financial, banking, fiscal and agricultural institutions along the lines pioneered by the Dutch
By accelerating technical progress and investing in physical capital, education and skills
By reformations in commercial trade policies: reducing protective duties on agricultural imports and eventually removing all trade and tariff restrictions
Europe (18th century-current) > Figure 1.10:
Massive outflow of capital for overseas investment (end 19th – beginning 20th centuries)
Collapse of trade, capital and migration flows and slow economic growth due to the two world wars and the Great Depression (mid-20th century)
The world economy starts growing again, and becomes more closely connected than ever before (end 20th century)
* International trade and MNEs
After the before provided historical overview of the world economy, it is clear that there are two waves of globalization: the end of the 19th century until the beginning of the 20th century and after the Second World War.
Globalization is not only due to macro-economic forces, but also to effects of micro-level enterprises.
§A.4 ‘The global economy- a detailed analysis’
Economic globalization = ‘The increased interdependence of national economies and the trend towards greater integration of flows of goods, labour and capital markets’.
Only focusing on the volume of these flows gives a biased view of the degree of globalization. Two examples to illustrate this: the price wedge and fragmentation.
* The price wedge
Basic economic picture: a downward-sloping demand curve (people buy less if a product becomes more expensive) and an upward-sloping supply curve (firms produce more if the price rises). Take Figure 1.11, international trade flows can also be depicted in this most basic framework, with two twists:
Home’s demand curve for imports is the home’s demand for the good not provided by the home’s domestic suppliers. Similarly, this applies for the Foreign’s export supply curve
There may be a number of reasons for a deviation between Home’s and Foreign’s price > The price wedge = for example, because foreign firms have to overcome certain transport costs, tariffs, trade impediments, cultural differences, et cetera.
Point A: price wedge = paH – paF > 0, resulting in volume qa. From point A, rises in international trade flows can occur for two basic reasons:
A shift to the right in either demand or supply at a constant price wedge will result in increasing trade flows. In Figure , demand shifts to the right > international economy moves to point B, trade flows move from qa to qb (constant price wedge: paH – paF = pbH – pbF). Generally: increased globalization if the rise in trade flows is larger than the rise in production
Price wedge diminishes, resulting from for example lower tariffs or lower transportation costs. If the price wedge completely disappears, the international economy would move to point C
* The price wedge in history
According to O’Rourke and Williamson, early growth of international trade was of the first kind: a shift to the right in either demand or supply, as the importing countries themselves could not produce the goods then exported (spices, coffee, tea and sugar). Usually, these were expensive luxury items and their buyers could afford to pay the price wedge.
The two waves of globalization (Figure 1.10) explain the second kind of growth in international trade: decreasing transport costs, technology improvements, falling trade restrictions, international cooperation, the removal of trade restrictions and improved communication possibilities all led to a decreasing price wedge.
The development of the price wedge in between the two waves of globalization (decrease in the first wave, increase during the World Wars and a decrease in the second wave) is also visible on the capital market. As you compare Figure 1.10 with Figure 1.13, there are two waves of globalization in the capital market as well.
Generally, real wage differences between countries explain the direction of migration flows to a very large extent.
Fragmentation = Technological and communication advances have enabled many production processes to be subdivided into various phases which are physically separable > Figure 1.15. The fragmentation process is facilitated by service links such as transportation, telecommunications, insurance, quality control and management control. Fragmentation helps to clarify why some phases of the production will be internally organized and why some phases will be outsourced.
§B.1 ‘Firms going abroad- multinational activity’
Note: This paragraph is made clear with the help of Figure 2.1 in the book.
Firms go abroad and cross their national border to generate value added. In this context, the first question to be asked is whether a firm wishes to serve foreign clients or source from abroad.
The most important reason for firms starting to engage in international business activities is their wish to sell their goods in a new market in order to make a profit. Serving this new market can be done in two ways (horizontal multinational):
Produce at home > export
Produce in the host country > directly sell
Sourcing from abroad can be done in two ways (vertical multinational):
Owning and controlling activities abroad
Horizontal multinational = market seeking, a firm starts producing and selling products or services to clients in a host country (the value chain moves horizontally to a different location)
Vertical multinational = efficiency seeking, a specific part of the production process can be done more efficiently in another country, so only a part of the value chain is moved to another country
> See Figure 2.2
International trade increases the degrees of freedom for an economy. Without trade, all domestic consumption must be supplied by domestic producers.
Advantages for consumers
Buying from foreign sources (more choice)
Comparing prices internationally
Rises in welfare (partly due to the above)
Advantages for firms
Bigger (export) market
Disadvantages for firms
§C.2 ‘Comparative advantage- David Ricardo’s contribution’
The concept of comparative advantage will be explained with the help of the following table (See attachment table 1):
David Ricardo focused on technology differences between countries as a prime reason for countries to engage in international trade ;
Looking at the table, you see that the USA have an absolute advantage in both cloth and wine. Given that the USA are more efficient in the production of both goods, why would they still engage in international trade at all? > “By focusing on the production of those goods in which a country is relatively more efficient both countries can gain from international trade.”
Back to the table: The USA is six times more efficient in the production of cloth (6/1) and two times more efficient in the production of wine (4/2) than the EU.
Conclusions: The USA have a comparative advantage in the production of cloth and the EU has a comparative advantage in the production of wine, as it is least disadvantaged compared to the USA.
Now we know the comparative advantages of both countries, how is it beneficial for both countries? > Suppose: USA 4 hours available for wine and cloth, EU 12 hours available.
This leads us to table 3.2 (See attachment table 2)
As you can see, if both countries specialize to their comparative advantage, world production is the highest. If they would produce against their comparative advantage, world production would be way less (12 cloth and 16 wine).
Price of a commodity = measure of how to be sure that specialization takes place according to comparative advantage. Under perfectly competitive conditions, with constant returns to scale and only one factor of production:
PoC = wage rate per hour / labour productivity per hour
In the USA, only 1/6 hours of labour are needed to produce one unit of cloth, making the price of cloth 1/6 times the USA wage rate
In the EU, 1 hour of labour is needed to produce on unit of cloth, making the price of cloth 1 time the EU wage rate
Consumers will buy the cheapest product, so they will only buy USA cloth if the USA cloth are cheaper than EU cloth: Pus,cloth
The same goes for wine: Peu,wine
Combining the two inequalities leads to a range of possibilities for the wage rate in the EU relative to the wage rate in the USA:
1/6 = (1/6)/(1/1)
* Box 3.1
See Figure 3.1 and keep the before explained Ricardo model in mind: countries with a low labour productivity (Brazil, $11.48 per hour) have a low income level per capita ($10.079). Countries with high labour productivity (Norway, $76,76 per hour) have a high income level per capita ($60.218).
> The line in Figure 3.1 is a regression line (Recap: Statistics I), where on average a one dollar higher level of productivity leads to an $828 higher GDP.
§C.3 Differences between comparative advantage and competitiveness
This paragraph stresses the differences between countries and firms when it comes to competitiveness. Later on in box 3.2, the difference between comparative advantage and competitiveness becomes clear.
First, if a firm is more expensive than another firm that makes a similar product, it cannot sell its product and will thus no longer be able to pay its workers, its owners or its bank and goes bankrupt. (Recap: Paragraph C.2, the USA and the EU). Countries where these firms operate in, however, never go bankrupt. They cannot close their doors and sell all their remaining assets > They will shift resources to other occupations.
Example : What happens if the wage ratio is not within the limits as imposed in paragraph 3.2? If the USA wage rate becomes seven times as high as the wage rate in the EU, all demand will shift to the EU. This leads to a decrease in labour demand and consequently to a decrease in wages. The USA can restore their competitiveness by making sure their wage rate is within the limits derived from comparative advantage again.
Conclusions : Market forces make the Ricardian model work. The fact that firms within a sector go bankrupt can be a sign that comparative advantage works.
Second, it might be bad news for firms if main foreign competitors gain market share, but this doesn’t have to hold for countries.
Example : For Sony (Japan) an increase in market share for Philips (the Netherlands) may be a sign that the Japanese production costs are relatively high and the Netherlands have a comparative advantage. Sony eventually will have to close its doors or move its production to a country that does have a comparative advantage in the electronics industry.
This type of reasoning does not hold for countries: a high growth rate in the Netherlands is good news for the Japanese firm, as they will face a larger export market in the Netherlands (the gain in market share also meant a gain in welfare).
Third, the process of specialization according to comparative advantage may seem unfair to individual firms. It is important to understand that the theory of comparative advantage shows that even if a firm is more productive than its foreign competitor, it might still lose market share because other domestic firms might have a higher productivity advantage relative to foreign firms.
Fourth, many multinational firms in developed countries move (or plan to move) their low-skilled activities to low-wage countries. This is often seen as a very unpleasant effect of globalization, as it drives home country wages down. This may happen for two reasons:
Firms relocate their activities in foreign countries > In the home market the employees of that activities lose their jobs
Even the threat of relocation may force wages in the home country down, as the home country wants to prevent relocation
What actually happens is that a low wage country is specializing according to its comparative advantage (low-skilled assembly activities) and the high-wage country loses a sector due to a comparative disadvantage (in low-skilled assembly activities).
Conclusions : Relocation of production activities may be a manifestation of comparative advantage
Finally, a current account deficit is sometimes seen as an indication that a country is less competitive than other nations. As a matter of accounting, the sum of the current account balance is always equal to zero. A current account surplus (profit) or deficit (loss) is determined by macro-economic forces (relation between savings, investment and international lending) and not by specialization according to comparative advantage.
* Box 3.2
Thomas Friedman: The World is Flat. In this book, fears around globalization are reflected. Distance is no longer a dominant characteristic of the world economy. Competition is thought to be a race to the bottom, with the lowest wage countries as the big winners where the high-wage countries lose market share in favour of low wage countries. The world is getting smaller and the ICT revolution has only just began.
> Critics : The theory of comparative advantage tells us that this view is way too simple. Countries always have a sector in which they have a comparative advantage . Even if they are less productive on all accounts, they and their competitors all benefit from international specialization according to comparative advantage (Recap: paragraph C.2).
§C.4 Comparative advantage- another approach
Around the 1930s, neo-classical economists became unhappy with the notion that trade was explained by differences in productivity and technology alone. They started to realize that if technology itself might not be too different between countries, other factors could also be responsible for productivity differences.
Differences in factor endowments = Other factors than technology that determine the level of trade and which country is more productive than another. The France climate, for example, is better for growing grapes than the Dutch climate. Here not technology is determinant for export, but climate.
* The Heckscher-Ohlin model
The H-O model, or the factor abundance model, explains international trade only through differences in endowments between countries. Six assumptions:
There are two countries, each producing two homogeneous products (Cloth (C) and Steel (S), using two production factors (capital (K) and labour (L)). Country 1 is said to be relatively well endowed with labour, compared to country 2
The production functions are identical for the two countries, but they have different factor intensities. We assume that steel is more capital-intensive than cloth
The supply of capital and labour differs between the two countries. Perfectly mobile within sectors within the country, perfectly immobile between countries > Factor prices are the same in the two sectors within a country
Production is perfectly competitive, constant returns to scale
Consumer preferences are the same in the two countries > the same price of cloth relative to steel, the consumption ratio of cloth relative to steel is the same
No barriers of trade
Factor price = the sale price set for a finished good or service is affected by the expense involved in the creation and manufacture of that product. The general idea is that the factor price is arrived at by taking into consideration all the factors of production.
One of the most important assumptions of the H-O model is that countries use the same technology in each sector. Coe an Helpman did research on this and they found that if a country has trading partners with a large stock of R&D, the country benefits form that foreign R&D base through trade. So, technological knowledge tends to converge between countries. In a continued study, they found that developing countries benefited from developed countries’ R&D investments > For results, see figure 3.3.
Horizontal axis: education-weighted ratio of a country’s foreign knowledge stock
Vertical axis: ratio of factor productivity (efficiency of the production process)
Take Niger as an example: the change in foreign knowledge stock is 2.02, but only 4% of the population completed secondary education > the population cannot effectively use the foreign technology
§C.5 Perfect competition and optimal production
Recap: micro economics ; price equals cost. In the long run, profits in perfectly competitive markets become zero, due to other suppliers constantly entering the market
Keep this theory in mind in this paragraph!!
The cost of production = labour needed to produce good X and the amount of capital needed to produce good X ; pX = costs = Labour for X * Wage + Capital for X * Rental rate
In short: pX = cost = Lx*w+Kx*r under the H-O model assumptions
Rewriting the formula > Kx = (costs/r) – (w/r) * Lx
This formula provides all combinations of labour and capital inputs with the same costs of production (w and r). Figure 3.5 shows these combinations as isocost lines. The slope of the lines is equal for every line > -w/r. The total costs are determined by the y-intercepts; more labour and capital means higher total cost and a higher y-intercept.
Now, if you want different combinations of labour and capital to yield the same level of total cost, you can use an isoquant. An example of an isoquant is illustrated in Figure 3.4.
Applying this theory
The lowest possible cost of production is determined by the intersection of the isoquant with one of the isocost lines ; Point A0 in Figure 3.5
If the slope changes (one cost of production becomes relatively more expansive than the other), the lowest possible cost of production also changes ; Point A1 in Figure 3.5
Unit-value isoquants = represent the production of each good that is worth one dollar of revenue when selling it. See Figure 1.6a, where the price of steel is pS and the price of cloth is pC0 and the isoquants for steel and cloth are 1/pS and 1/pC0.
If the price for steel is pS, we only have to produce 1/pS to get one dollar of revenue (pS*1/pS=1) ; so the unit value isoquant is inversely related to the price
The minimum cost combinations of capital and labour for both unit value isoquants must be points where both isoquants intersect a isocost line (steel0 and cloth0)
Price changes ; if the price for cloth increases from point pc0 to pC1, we have to produce less cloth to get one dollar of revenue, so its isoquant shifts more towards the origin (1/pC1). The minimum-cost output is now at cloth1,steel1 ; the slope of the isocost line has increased (w>r)
§C.6 Appliance of the Heckscher-Ohlin model
What happens in a trading equilibrium? When taking a look at Figure 3.5 and point A0 and A1, it is clear that country one is relatively more labour-abundant and country 2 is more capital-abundant. See Figure 3.7 (Figure 3.6b is copied in Figure 3.7) > as country 1 is more labour-abundant, (w/r)1
Once international trade is possible:
Individual consumers exploiting arbitrage opportunities between the two countries will ensure that the price of cloth and steel will get the same in both countries
The trade equilibrium price will be anywhere between the two autarky prices (pC/pS)tr in Figure 3.7
(pC/pS)tr is above the trade equilibrium price for cloth in country one (excess supply) and below trade equilibrium for cloth in country two (excess demand) > Country one starts exporting cloth
(pC/pS)tr is above the trade equilibrium price for steel in country two (excess supply) and below trade equilibrium for steel in country one (excess demand) > Country two starts exporting steel
Conclusions : The above described is the Heckscher-Ohlin theorem > “A country will export the good that intensively uses its relatively abundant factor of production, and it will import the commodity that intensively uses its relatively scarce factor of production”
From the points of intersection of the unit value cost line and the isoquant with the axes we can determine the wage rate and the rental rate (must be the same in both countries)
Factor price equalization = an effect observed in models of international trade that the prices of inputs to (factors of) production in different countries, like wages, are driven towards equality in the absence of trade barriers (open economies)
Wrap up: The difference between the Ricardian model and the Heckscher-Ohlin model is that the Ricardian model assumes that technology differences, resulting in wage differences between countries, cause international trade. The H-O model assumes that differences in factor endowments trigger international trade. In both models the prices of final goods will be equalized, but in the H-O model, also factor prices will be the same in equilibrium.
Section 2.2 elaborated on the differences between comparative advantage and competitive advantage for the Ricardian model. To a large extent, the same discussion goes for the H-O model, where firms producing the same commodity compete with each other in the international market. In equilibrium, they cannot be more expensive than their competitors in order to maintain market share. Once factor prices are equal, so will production cost be, but until factor prices are equalized, cost differences will determine the competitive position of firms.
Globalization = The process of integration across world-space. Has 5 dimensions.
Cultural globalization = The debate whether there is one big global culture or a set of universal cultural variables, and the degree to which these universal cultural variables displace embedded national cultures and traditions.
Economic globalization = The decline of national markets and the rise of global markets.
Geographical globalization = The result of ‘joint time and space’ due to reduced travel times and the rapid (electronic) exchange of information.
Institutional globalization = The spread of universal institutional regulations across the world.
Political globalization = The relationship between the power of the market (multinational corporations) versus the nation-state, which continuously has to make changes and updates in reaction to economic and political forces.
GDP per capita GDP per capita = Gross domestic product divided by the population. The GDP is the sum of gross value added by all producers in the economy.
Price wedge = Deviation between home-and foreign’s price, due to for example foreign firms having to overcome certain transport costs, tariffs, trade impediments, cultural differences, et cetera.
Fragmentation = Technological and communication advances have enabled many production processes to be subdivided into various phases which are physically separable.
Horizontal multinational = Market seeking, a firm starts producing and selling products or services to clients in a host country (the value chain moves horizontally to a different location).
Vertical multinational = Efficiency seeking, a specific part of the production process can be done more efficiently in another country, so only a part of the value chain is moved to another country.
Comparative advantage = The ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.
Absolute advantage = The ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources
David Ricardo = Focused on technology differences between countries as a prime reason for countries to engage in international trade in his Ricardian model.
Price of a commodity = Measure of how to be sure that specialization takes place according to comparative advantage. Under perfectly competitive conditions, with constant returns to scale and only one factor of production.
Differences in factor endowments = Other factors than technology that determine the level of trade and which country is more productive than another.
The Heckscher-Ohlin model = The factor abundance model, explains international trade only through differences in endowments between countries under six assumptions
Factor price = The sale price set for a finished good or service is affected by the expense involved in the creation and manufacture of that product. The general idea is that the factor price is arrived at by taking into consideration all the factors of production.
Perfectly competitive markets = No participants are large enough to have the market power to set the price of a homogeneous product.
The cost of production = Labour needed to produce good X and the amount of capital needed to produce good X ; pX = costs = Labour for X * Wage + Capital for X * Rental rate
In short: pX = cost = Lx*w+Kx*r under the H-O model assumptions.
Isocost lines = Represent different combination of factors of production with the same total cost, given the factor prices.
Isoquants = A graph depicting different combinations of factors of production yielding the same level of total cost.
Unit-value isoquants = Represent the production of each good that is worth one dollar of revenue when selling it.
Factor price equalization = An effect observed in models of international trade that the prices of inputs to (factors of) production in different countries, like wages, are driven towards equality in the absence of trade barriers (open economies).